U.S. Dollar: What Can Break The Range?

Last updated 6/19/2009 5:22 PM ET (GMT -5) 2 Comments

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• U.S. DOLLAR: WHAT CAN BREAK THE RANGE?
• EUR/USD: RATE CUTS STILL ON THE TABLE?
• GBP/USD: LIGHT WEEK AHEAD
• USD/CAD: DRIVEN LOWER BY WEAK RETAIL SALES
• AUD/USD: GOLD PRICES EDGE HIGHER, OIL BELOW $70
• NZD/USD: GDP AND CURRENT ACCOUNT NEXT WEEK
• USD/JPY: JAPANESE YEN CROSSES RECOVER

EXPECTATIONS FOR UPCOMING FED MEETINGS

U.S. DOLLAR: WHAT CAN BREAK THE RANGE?

A cursory glance at the foreign exchange market will reveal a consolidated tone across the majors. This is partially due to the summer doldrums but also to the uncertainty in the financial markets. The U.S. dollar ended the week modestly lower against the Japanese Yen but virtually unchanged against the Euro and British pound. This lack of volatility comes after the sharp sell-off in the dollar over the past 3 months and nearly all of the major currency pairs are setting up for a breakout. Although the summer doldrums should reduce volatility in the currency market, the apex of the triangle formations in EUR/USD, GBP/USD and USD/JPY point to a large expansion in volatility (ie. a possible breakout move) as early as next week.

What Can Trigger a Breakout?

Sometimes nothing more than the lack of liquidity could cause a breakout in the currency market. No major surprises are expected in U.S. economic data next week with only housing market reports, durable goods, the final release of first quarter GDP and the Federal Reserve interest rate decision on the calendar. If the Fed expanded their asset purchases or becomes more optimistic, it could trigger a break in the EUR/USD, but we expect the central bank to keep the tone of the FOMC statement basically unchanged. The only real possibility is a mention of exit strategies, but so far currency traders have shrugged off similar talk by the ECB and BoE. Instead, what could trigger a breakout are exogenous events such as growing tensions with North Korea, downgrades or higher taxes. The late afternoon sell-off in the dollar on Friday was driven by speculation that rating agency Moody’s could downgrade California’s debt rating. California’s fiscal finances are a mess, prompting Governor Schwarzenegger to even consider a flat tax.

Forex Traders Adjusting Positions

A few weeks ago, we talked about the exaggeration of dollar short positions in the futures market but these positions have recently been trimmed. Based upon the latest CFTC’s Commitment of Traders report as of the week ending June 16th, futures traders reduced their long positions in the Euro and Swiss Franc but raised their long exposure in the Australian and Canadian dollars. They have also boosted their short Yen positions but cut their short British pound exposure. These changes are not extremely surprising since strong economic data and higher oil prices make the commodity currencies more attractive on a fundamental basis while the lack of official reserve diversification talk by the BRIC nations has forced dollar bears to adjust their positions.

Forex Seasonality: Summer Volatility

Two months ago, we published an article illustrating the seasonal patterns of volatility in the currency market using ten years worth of three month at the money option volatilities. According to our results, volatility tends to compress in June and July but pick up in August. Here are the charts of average EUR/USD and USD/JPY volatility across different months and so far price action appears to be obeying the seasonality.

Marc Faber: The Gloom, Boom & Doom Report

EUR/USD: RATE CUTS STILL ON THE TABLE?

The EUR/USD has once again attempted to but failed to close above the psychologically significant 1.40 level. German producer prices was the only piece of noteworthy Eurozone data released this morning and unfortunately the report created little fireworks after printing in line with expectations. PPI growth was flat in May, driving the annualized pace of contraction to 3.6 percent from 2.7 percent. This will keep the European Central Bank committed to its loose monetary policy. ECB member Paramo even went to so far to suggest that the central bank could still cut interest rates. More specifically he said that “we have not decided that 1 percent is the lowest imaginable rate in any scenario.” Concerns about the European financial sector are preventing the EUR/USD from breaking the 1.40 level. Rating agency Moody’s downgraded five of Poland’s largest bank and is still considering possibly downgrading the ratings of 21 Italian banks. The front of next week is dominated by European economic data with the German IFO report coming out on Monday followed by PMI numbers on Tuesday. The improvement in investor sentiment and the uptick in manufacturing PMI last month could boost business confidence. However activity in the manufacturing and service sectors this month could slow due to the residual effects of Euro strength. ECB President Trichet will be speaking on Monday.

GBP/USD: LIGHT WEEK AHEAD

The British pound was one of the few currencies to end the week incrementally higher against the U.S. dollar. However more importantly, the currency pair closed around 1.65 and is trading within an arm’s reach of its 7 month high. This past week’s economic data was mixed and yet currency traders prefer the pound over many of the other major currencies. For example, the pound has also broken below 85 cents against the euro with EUR/GBP closing in on its year to date lows. Next week, the U.K. economic calendar is devoid of any meaningful data which means that dollar sentiment will continue to determine price action of the GBP/USD. The only releases that we expect are house prices and the CBI Distributive Trades survey. Bank of England officials are expected to testify on Thursday, which is the only time we could expect some sterling driven activity in the GBP/USD. Bank of England member King believes that it is too early to draw strong conclusions about the recovery because “no one knows what will happen. It's very easy to lose confidence quickly and indeed it was lost in a very short period of time. You can't regain it quickly, so it's bound to take a lot longer to recover than it was to fall into recession, which was a very sharp fall in activity over the last six months. I don't think it would be sensible to expect activity to pick up as quickly."

USD/CAD: DRIVEN LOWER BY WEAK RETAIL SALES

The only major release on the calendar today was the Canadian retail sales report for the month of April. Consumer spending fell for the first time this year, driving the Canadian dollar lower against the greenback. Spending on cars and gasoline dropped 1.9 percent, reducing overall spending by 0.8 percent; sales ex-autos declined 0.5 percent. Although this was a bearish report, consumer spending was unusually strong in the first 3 months of the year, so a correction is not out of the ordinary. Also, the labor market has deteriorated materially with the unemployment rate hitting an 11 year high last month. Yet the Bank of Canada will be in no rush to jump start their Quantitative Easing program after the hotter inflation report yesterday. At 2.0 percent, the annualized pace of core CPI growth is still consistent with the central bank's target. Last night, Bank of Canada Governor Carney warned the FX market that he is still watching the loonie closely. This is the third time this month that he has expressed concern about the Canadian dollar's rise. Despite the recent correction, the currency still appreciated 12.8 percent since March. The strength of the Canadian dollar offsets the benefits of higher oil prices and threatens the nation's recovery. USD/CAD below 1.15 is very damaging for Canadian exporters. Carney even went so far to say that currency intervention is always an option although "intervention itself without policy action consistent with the direction of that intervention is rarely effective in the long term." Despite lack of economic data, the Australian and New Zealand dollars extended their gains. The focus next week will turn to New Zealand as they have GDP and the current account balance due for release.

USD/JPY: JAPANESE YEN CROSSES RECOVER

The Japanese Yen traded higher against the U.S. dollar, Euro and Canadian dollar but sold off against the British pound, Australian and New Zealand dollars. According to the minutes from the May Bank of Japan monetary policy meeting, the central bank recognized the recent improvements in economic data and financial conditions but remained downbeat about the state of the economy. The consumer price report is the most important piece of economic data from Japan next week. The market expects inflation to ease further, raising fears of deflation. The recent weakness of the Japanese Yen should also help to bolster the trade balance, but with global demand still tepid, we do not expect a meaningful pickup in trade.

EUR/USD: Currency in Play for Next 24 Hours

EUR/USD will be the currency in play for Monday. Early on Monday, German IFO figures will be released which includes Expectations, Current Assessment, and Business Climate at 8:00GMT or 4:00AM EST. After hitting a year to date high earlier this month, the EUR/USD has declined over the past few weeks and is currently lingering in the Range Trading Zone, which we determine using Bollinger Bands. However, the pair managed to create a bullish flag, suggesting potential gains in the future if EUR/USD breaks to the upside. In order to continue its intermediate rally, the pair must break current resistance. Current resistance hovers exactly at 1.4000, which represents the 20-day SMA as well as 38.2% retracement of April’s low and this year’s high. Nonetheless, if the pair manages to fall below the 1st Standard Deviation of the Bollinger Bands, expect the next level of support to be at 1.3785 which represents the 50% retracement of April’s low and this year’s high.

Comments (2)

Eddie09

June 22, 2009 at 05:24 PM ET

Hi Cathy, The USD continues to be strong these days. It even rallied on bearish data against CAD and EUR today.

Do you think that the current USD strength partly due to the Fed’s interest rate announcement schedule on Wednesday? ( the market is now pushing the USD higher ahead of the announcement because there could be a chance or a risk for interest rate hike by the Fed?)

klien

June 22, 2009 at 05:31 PM ET

Read my daily report from today which explains why the Dollar rallied

http://www.fx360.com/commentary/kathy/1438/consolidation-is-not-dollar-positive.aspx

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About The Author

Kathy Lien began her FX trading career 10 years ago at J.P. Morgan Chase. After graduating New York University’s Leonard Stern School of Business at the age of 18, Kathy joined the bank's interbank FX trading desk and eventually moved to the cross markets proprietary trading desk. In the interbank market, her ability to create solid fundamental and technical analysis from the myriad of information on the market helped her trade forex spot and options. Her experience eventually led her to be chief strategist at Daily FX where she worked until she joined GFT in 2008.

With her knowledge of forex, as well as her experience trading other products, such as interest rate derivates, bonds, equities, and futures, Lien has built a reputation as an international currency analyst. She is frequently quoted on CNBC, Bloomberg, Fox Business and Reuters. Lien has also written for publications like Active Trader, Futures, and SFO magazine. She is the author of the newly updated Day Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Boris Schlossberg.

To buy Kathy’s newly updated Day Trading and Swing Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, click here.